The collapse of Thomas Cook

Elements that played a role in the compulsory liquidation

Breaking news on Sunday evening: The world’s oldest tour operator Thomas Cook announced that it entered into compulsory liquidation. As a result, around 600,000 travellers were stranded worldwide, some of them even held hostage at their Tunisian hotels. Huge repatriation projects were immediately set up in order to bring everybody home. Meanwhile also around 21.000 jobs are at risk!

If we look at the stock price evolution of the company over the past 10 years, the least we can say is that it has been a bumpy road: dropping to historical low levels in 2012 following the Arab spring, strongly recovering the years after, becoming profitable again in 2015, but then gradually going down again…

Let’s analyse what happened, starting with some key financial figures: When analysing financial stability of companies, we typically compare operating cash flow generation (proxied by the EBITDA) with the net debt outstanding. While debt has gradually been piling up over the past years, the operating cash flow generation worsened as of 2018 and EBITDA became even negative in the ten month period preceding the 31st of July of this year, while the net debt amounted to almost 1.5 billion pounds.

Various reasons driving the collapse can be identified: A first and most important factor is the competition of disruptive online players like Booking, Airbnb and Expedia, as well as the rise of low-cost airlines. However, also internal reasons, like value-destroying acquisitions in the past, played an important role. The 2007 MyTravel acquisition, for example, still led to a £1 billion write-off a couple of months ago. On top of that, some unfortunate circumstances, like last year’s heatwave and also the Brexit worsened the situation, through lower consumer confidence and a drop in the pound.

Now, what can companies do in case of financial distress? Well, they basically have three options in line with the three types of cash flows:

  • First, companies should work on improving their operating cash flows by becoming more efficient and adapting their business model but that can typically only be realised in the relatively long term.
  • Second, companies can cut on their investment spending or even start divesting certain parts of their business and use the proceeds to pay off loans. In that respect, Thomas Cook considered the sale of its airline division earlier this year.
  • Finally, they might count on their investors to provide new capital or negotiate a debt restructuring with their debtholders.

In the case of Thomas Cook, a £900m rescue deal was negotiated and structured as follows:

  • Fosun, a Chinese investment company and largest shareholder of Thomas cook, agreed to invest another £450 million that would result in a stake of 75% of the equity of the tour operator business and 25% of the group’s airline
  • The group’s core lending banks and bondholders, at the other hand, would also bring in £450 million of new money and convert their existing debt into approximately 75% of the equity of the airline business and up to 25% of the tour operator

But…

Last week Thomas cook’s lending banks (led by RBS and Lloyds) demanded an additional £200 million as “a seasonal standby facility”  - following advice from financial consultants working for the banks – because of risk of running out of cash again, especially in the cash low winter season.

In addition, one can question whether all debtholders had the right incentives to go for a deal, as several bondholders purchased credit default swaps allowing them to insure the default risk. These contracts of course only result in payments in case of actual default. Several hedge funds also heavily invested in CDS of Thomas Cook, resulting in expected gains of around 250 million dollars in total! So some investors were definitely happy on Sunday evening.

If all of this does not work, one option is left and that is turning towards the government, so a request was made to the government for around £150 million but the British government refused and Boris Johnson explicitly referred to the risk of creating a moral hazard problem in case of future commercial difficulties that companies might face. This left the 178-year old company no other choice than to opt for liquidation…

Finally, let’s take a look at how stock prices of other companies in the sectors are reacting. First of all, the stock price of TUI jumped on Monday morning by almost 10% as a result of the collapse of its rival. In addition, the stock price of rival airlines also showed positive reactions, with Ryanair’s shares up almost 3% and Easyjet shareholders even gaining 6%.

So, you can indeed say that one man's loss clearly is another man's gain!

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